CRE Finance Council (CREFC) has announced the release of its new and comprehensive market standards for “CMBS 2.0,” which will build on existing safeguards to ensure the timely resurgence of a sound and vibrant commercial real estate finance market. These standards are the culmination of an extensive year-long project that has resulted in improvements in three critical areas: Loan underwriting; additional disclosure; and representations and warranties.
Each of CREFC’s initiatives reflects the consensus views of the organization’s entire membership, which includes lenders, issuers, servicers, and loan and bond investors. The goals of CREFC’s new ‘best practices’ are to create market standards that can be used in the commercial mortgage-backed securities (CMBS) market immediately and to provide support to U.S. federal regulators as they work to implement the Dodd-Frank Act’s goal of better aligning investor and originator interests.
CREFC’s Principle-Based Underwriting Framework identifies underwriting principles needed to address credit-risk in commercial mortgages and the Standardization of the Annex A builds on the unparalleled disclosure in the CMBS market. CREFC’s Model Representations and Warranties and Model Repurchase Remediation Language initiatives provide consistent and enhanced assurance by originators and issuers for their underwriting standards and loan quality as well as an efficient dispute resolution mechanism for representation and warranty breaches. Each of these projects complements the CRE Finance Council’s longstanding tradition of providing ongoing transparency and disclosure through the CREFC Investor Reporting Package (IRP). Similar to the IRP, the initiatives will be constantly reviewed and updated as the market evolves.
“The release of CREFC’s best practices is an important and timely milestone in the commercial real estate finance market, a sector that has turned an important corner in 2011,” said Lisa Pendergast, president of the CRE Finance Council. “CREFC’s members— across all constituencies—have devoted an extraordinary amount of time over the past year to strengthen the market and provide important standards for commercial mortgages. We thank each of them for their extraordinary efforts to ensure a sound and vibrant commercial real estate finance market.”
Together, CREFC’s market standards enhance disclosure, encourage consistent and responsible underwriting and align interests in a manner that is consistent with the Dodd-Frank Act’s risk-retention requirements. Under the Dodd-Frank, risk retention for commercial mortgages can be satisfied in a number of ways, including one or more of the following “adequate” underwriting standards and controls; “adequate” representations and warranties and related enforcement mechanisms; and a percent of the total credit risk of the asset held by the securitizer, originator or a third-party investor. The CREFC initiatives specifically address the Dodd-Frank mandate for commercial mortgages by creating standards for use in the market immediately while retention rules would not go into effect for an additional two years after they are finalized, or April 2013.
“CREFC is committed to building on existing safeguards to promote certainty and confidence in the commercial real estate finance market,” said Margie Custis, managing director of capital markets, principal global investors, and co-chair of CRE Finance Council’s CMBS 2.0 Advisory Committee, which oversees all of the CREFC’s standard setting and best-practices efforts. “We believe CREFC’s standards are consistent with the risk-retention provisions in Dodd-Frank and go beyond the required government directives to improve transparency and promote a strengthened foundation. We have little doubt that our industry’s initiatives will help commercial real estate in its recovery efforts.”
A summary of the CRE Finance Council initiatives released are as follows:
►Model Representations and Warranties standardize the representations and warranties that lenders must make concerning the qualities and characteristics of the loans and due diligence performed on the borrowers and properties. These representations and warranties will now be standard across the industry, and issuers are expected to present prospective bond investors with a comparison (via blackline) of any changes made from the CREFC Model to a deal’s representations and warranties. Additionally, loan-by-loan exceptions to the representations and warranties should be disclosed to prospective bond investors. Dodd-Frank specifically recognizes ‘adequate’ representations and warranties as one of several risk-retention options for commercial mortgages because issuers and originators would be held accountable for losses sustained on loans that failed to meet the specified characteristics.
►To further enhance and enforce the Model Representations and Warranties, the Model Repurchase Remediation Language creates a process to resolve breach claims in an expedited, reliable, and reasonable fashion through mandatory third-party mediation prior to the commencement of any legal action. Mediation does not preclude such legal action, but it provides a forum in which repurchase demands can be processed in an efficient and timely manner to the benefit of all parties involved.
►Principles-Based Underwriting Framework is a set of principles that help identify underwriting principles and procedures designed to generate lower credit risk loans. Importantly, however, commercial properties and their related markets are unique and therefore the risk analysis for the related loans must be property and sponsor specific. The Dodd-Frank Act directs regulators to identify underwriting standards indicating that loans are “low risk” and might be exempt from a retention requirement. The Act also highlights ‘adequate’ underwriting standards and controls as an option for risk retention.
►Annex A is a chart providing more than 180 data fields for each loan and related property collateral in a securitization that is included as an attachment to the disclosure document given to investors during the offering of a CMBS issuance. CREFC’s IRP tracks ongoing loan, property and bond-level information, some of which is included in the initial Annex A. The changes in Annex A expand upon and standardize the initial information provided to prospective investors.
►CREFC’s market standards have been formally delivered to the Department of the Treasury, Federal Reserve Board of Governors, the Federal Deposit Insurance Corporation, Securities and Exchange Commission, and the Office of the Comptroller of the Currency, the agencies which are charged with promulgating risk-retention regulations.